Fed Policymakers Ponder Another Rate Cut

NEW YORK – After cutting interest rates five times in six months, Federal Reserve policymakers are about to repeat the process once more — while pondering what more they need to do to restart the ailing economy.

The Federal Open Market Committee, the panel responsible for setting the key federal funds rate, is expected to announce its decision at about 2:15 p.m. EDT Wednesday.

While Wall Street almost unanimously thinks the central bank will cut rates again, economists are divided over the magnitude of that move. Some think there has been and will be heated debate on the subject among policymakers during the meeting.

A smaller, quarter-percentage point reduction could buy the Fed time to assess how well its previous moves are working their way through the economy.

Meanwhile, a larger, half-point move would signal concern that growth has yet to pick up. The Fed has already slashed rates five times since January.

A Reuters poll of firms that trade directly with the Fed found 14 dealers expect the Fed to opt for the smaller easing, while 11 expected a larger cut.

Beginning Jan. 3 of this year, the Fed has cut interest rates five times in half-point moves that marked the central bank's most aggressive credit easing in 19 years.

Those cuts have pushed the federal funds rate, the interest that banks charge each other, from 6.5 percent down to 4 percent, a move that has been matched by commercial banks, which have lowered their prime lending rate, the benchmark for millions of consumer and business loans, from 9.5 percent down to a seven-year low of 7 percent.

Marginally Improving Economy

Three reports released Tuesday as the central bank began its deliberations all depicted an improving economy.

Consumer confidence rose for a second straight month, orders to U.S. factories for big-ticket manufactured goods from cars to computers jumped by 2.9 percent in May, the biggest gain since February, while sales of new homes rose a solid 0.8 percent with all parts of the country enjoying increases.

All those numbers are likely to add to the case for a smaller cut — but not decisively, analysts said.

"I don't think they were holding their breaths to see today's data," said Anthony Karydakis, senior financial economist with BancOne Capital Markets in Chicago. Still, Karydakis said he thinks the Fed will ease by only a quarter-percentage point.

Greenspan Walking a Fine Line

One reason the outcome of the meeting is a tough call for private economists is that Fed Chairman Alan Greenspan has done little to tip his hand in his public comments, even though some of his colleagues have dropped hints they might lean toward a more gradualist move of a quarter point.

"The Fed is trying to walk a fine line between those who still want more aggressive easing and those who think they may have already done too much," said Bill Cheney, chief economist at John Hancock Financial Services in Boston. "Given that, I'm expecting they'll probably compromise and do a token quarter point."

"It's a very close call," said Tim O'Neill, chief economist with Bank of Montreal/Harris Bank in Toronto.

O'Neill said he thinks the Fed will continue its pattern of half-point rate cuts, in view of "mixed" economic data lately.

Among the least ambiguous of that data are numbers for the manufacturing sector. According to the Fed's own numbers, U.S. industries are working at their slowest pace since 1983. Total industrial output has fallen for eight straight months. Job growth has also been slipping.

Risks of Inflation

O'Neill said the Fed will ultimately decide that the threat of near-term economic activity sputtering out overshadows the risk that, six to nine months down the road, activity will rebound sharply and usher in higher inflation.

But others, including some Fed officials, are counseling further patience, warning that easing too much now risks stoking inflation down the road when growth recovers.

Dan Seto, senior economist with Sumitomo Life Investment Co. in New York, said he expects a quarter-point move, but with the Fed leaving open the option of easing again before its next meeting in August.

Seto said inflation is not as dormant as many have been portraying it. "It's not a forest fire yet, but there's some sparks here and there," he said.

While economists are split on the size of Wednesday's rate cut, they are in general agreement that the rate reductions are drawing to a close.

"The rate cut we see tomorrow could well be the last because the economy should in fact start to show signs of stabilizing during the next two months as the interest rate cuts and tax cuts take hold," said Lynn Reaser, chief economist at Banc of America Capital Management.